By way of background, Glaxo Canada purchased ranitidine, the active pharmaceutical ingredient in Zantac, a branded ulcer medication, from a non-arm’s-length non-resident. In 1990-1993, Glaxo Canada paid approximately $1,500 per kg of ranitidine, while generic purchasers of ranitidine were paying approximately $300 per kg. The Minister of National Revenue reassessed Glaxo Canada under former section 69 of the Income Tax Act on the basis that the taxpayer had overpaid for the ranitidine in light of the fact that generic manufacturers were paying considerably less for the same ingredient.

The issue before the Tax Court was whether the amount paid by the taxpayer to the non-arm’s-length party was “reasonable in the circumstances.” The Tax Court held that (a) the “comparable uncontrolled price” (or CUP) method was the most accurate way to determine the arm’s-length price for ranitidine and (b) the appropriate comparable transactions were the purchases of ranitidine by the generic manufacturers. Subject to a relatively minor adjustment, the Tax Court dismissed the taxpayer’s appeal.

The Federal Court of Appeal allowed the taxpayer’s appeal. The Court of Appeal held that the lower court had erred in its application of the “reasonable in the circumstances” test, and that it should have inquired into the circumstances that an arm’s-length purchaser in the taxpayer’s position would have considered relevant in deciding what reasonable price to pay for ranitidine. The Court of Appeal set aside the lower court judgment and sent the matter back to the Tax Court to be reconsidered.

The Crown appealed and Glaxo Canada cross-appealed the portion of the order sending the matter back to the Tax Court. The appeal was heard by a seven-member panel of the Court (Chief Justice McLachlin, Justice Dechamps, Justice Abella, Justice Rothstein, Justice Cromwell, Justice Moldaver and Justice Karakatsanis).

The Crown argued that the analysis under subsection 69(2) required a “stripping away” of the surrounding circumstances of the transaction in question and, in particular, the license agreement pursuant to which Glaxo Canada was entitled to market and sell the drug ranitidine under the brand name Zantac. Having done that, the only relevant comparator was the price of ranitidine on the “open market”, namely, the price paid for ranitidine by generic drug manufacturers.

The Court asked a number of questions about whether subsection 69(2) (with its reference to “in the circumstances”) makes the ultimate use of the ranitidine relevant to the analysis. Several judges asked whether it made a difference that the ranitidine purchased by Glaxo Canada was to be marketed and sold as Zantac, a branded product that would yield a higher retail price than the equivalent generic product. Justices Abella and Rothstein were particular active during this discussion.

In stark contrast to the Crown’s position, Glaxo Canada contended that the only question to be answered under subsection 69(2) was whether two arm’s-length parties, sitting across a boardroom table, would arrive at the same deal that was concluded by Glaxo Canada and its non-resident parent company. Justice Abella wondered if, even in those circumstances, an arm’s-length party would pay $1,500 for a kilogram of ranitidine.

Chief Justice McLachlin asked about bundling and its relationship to transfer pricing – if the $1,500/kg price included an amount paid for something other than ranitidine why was it not identified by Glaxo Canada as such and why was withholding tax not remitted thereon under section 212 of the Act? Counsel for Glaxo Canada responded by making two points: First, if a portion of the price paid by Glaxo Canada for ranitidine were more properly characterized as royalties, for example, such amounts would be expenses to Glaxo Canada and thus there was no mischief from a transfer pricing perspective in bundling them into the cost of the goods. Second, it is not the policy or practice of the CRA to require taxpayers to unbundle intellectual property or other intangibles from tangible property as, presumably, the practical burden imposed by such a requirement would be difficult to overstate. It was unclear whether the tension between the issues of bundling and arm’s-length pricing was resolved at the hearing.

In a nutshell, the choice before the Court is this: Is the fact that the ranitidine purchased by Glaxo Canada was destined to become Zantac relevant to the analysis under subsection 69(2)? Glaxo contends that it is, while the Crown contends that it is not.

On the cross-appeal, Glaxo Canada argued that it had met the case against it on the pleadings and the matter should, therefore, have concluded at the Federal Court of Appeal and should not have been sent back to the Tax Court. There were a number of questions from the bench on that point.

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